3M, the maker of Post-it, will acquire Scott Safety from Johnson Controls for $2 billion to build up its safety division. This is the second largest acquisition for 3M after its purchase of Capital Safety, a maker of fall protection equipment such as harnesses, lanyards, and self-retracting lifelines, from KKR & Co. for $2.5 billion in 2015.

Scott Safety’s products include respiratory-protection products, thermal-imaging devices, and other products for firefighters and industrial workers. The company will become a part of 3M’s safety division, which accounts for 18% of the company’s sales in 2016 and is the second largest division.

3M is using acquisitions to boost slow growth in the US and to combat industry challenges in the consumer and electronic sector. In 2016, 3M executed a number of acquisitions and divestments as part of its realignment strategy. The company sold its temporary protective films business, safety prescription eyewear business, and pressurized polyurethane foam adhesives business. 3M also purchased Semfinder, a medical coding technology company.

Here are two lessons for leaders who are thinking about company growth.

1. Acquisitions can jumpstart growth.

When organic growth options such as, opening a new store or adding new products, fail to grow revenue significantly, it may be time to look at external growth. Strategic leaders evaluate shifting industry dynamics to anticipate future demand and then use acquisitions to reposition their companies to capture a share of the high-growth market. When completed, the acquisition of Scott Safety will add 1,500 employees, $570 million in revenue, and a slew of products immediately to 3M’s safety division.

2. Acquisition isn’t just about getting bigger.

Acquisition is truly about recalibrating your business and focusing on strategy. Although 3M is acquiring Scott Safety, the company also divested of a number of businesses in 2016 and is paring down from 40 business units to 25.

On the other hand, the seller, Johnson Control is also realigning their business with this divestment. “Consistent with our priority to focus the portfolio on our two core platforms of Buildings and Energy, we continue to execute on our strategic plan.” said Johnson Controls Chairman and CEO Alex Molinaroli.

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One of the most effective ways for strategic buyers to grow through acquisitions is to “take frequent small bites of the apple,” or to conduct a series of smaller, strategic acquisitions in order to achieve a growth goal. Even those these deals might not be as “exciting” as mergers between two huge competitors, they can be just as (or even more) impactful for an organization’s success.

A recent example of this approach is German chemical manufacturer Evonik, which is building its cosmetic ingredient business through acquisitions. On March 13, the company announced it will acquire cosmetic ingredient manufacturer Dr. Straetmans GmbH for $107 million. The deal is Evonik’s second in the cosmetic ingredient sector; last year, the company acquired Air Products and Chemical’s coatings and additive operations for $3.8 billion.

It is possible to achieve significant growth by executing smaller deals and sometimes an iterative process can be more effective than one sweeping change. Most of us have probably taken a class or read an article on leadership about achieving goals where a common suggestion is to break down a large goal into achievable steps. Executing a series of strategic acquisitions is similar. Each deal builds on the previous one, like a step in a staircase, bringing you closer and closer to your goal.

Change, even good change, can be difficult to process and many companies struggle when it comes to post-merger integration. This risk is greatly reduced with a small deal because it is easier to digest and there are fewer moving pieces. In between deals you have time to adjust, evaluate your newly merged company and determine when and how to pursue your next deal. This time of re-calibration between deals will help you build a strong foundation for achieving your dreams.

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Private equity firms are increasingly acquiring minority interests in public companies in order to grow, according to the Wall Street Journal. The landscape for PE is changing. Firms are facing tough competition from strategic acquirers who have cash on their balance sheets and are typically willing to spend more on an acquisition. At the same time, fewer banks are lending to private equity firms because of regulations that restrict the amount of debt allowed in acquisitions, making funding leveraged buyouts difficult.

In this challenging environment, minority interest may prove to be a path to growth. For PE firms, acquiring small stakes in public companies can pave the way to a 100% acquisition.

There are a number of advantages to minority interest for financial and strategic buyers.

1. Save Money

You have the opportunity to pursue external growth with a company that may be too expensive or too big for you to acquire in its entirety. For PE firms that are struggling to find financing, acquiring minority stakes allows them to pursue acquisitions despite limited funding.

2. Spread Risk

If you, like most business leaders, have limited financial resources to invest in acquisition, you can acquire several minority interest to spread your risk, while remaining within your budget.

3. Retain Key Management

It’s unlikely that the entire management team will leave when you acquire a minority stake. These experienced team members may stay on and continue adding value to the company for years to come.

4. Open Doors

Minority interest allows you to pursue opportunities that may not be open to 100% acquisition. It would be much more difficult for a PE firm to outright acquire a publicly traded company than it is slowly acquire minority stakes. For strategic acquirers, there may be not-for-sale owners who are not interested in giving up their entire company, but may be open to selling a piece of it.

5. Execute Your Strategy

Minority investment can be used to eventually acquire a majority stake on even the entire company. It’s common to build in options for the buyer to acquire additional stakes as time passes. For example, Disney acquired a 33% stake in video streaming company BAMTech and has the option to acquire a majority stake in the future.

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Trust is everything. As leaders, we can forget this during the excitement of a deal. We can get caught up in reviewing financials, bogged down in the details of due diligence, or absorbed in mountains of research and completely forget about the humans involved in the transaction. When you take a moment to think, it’s obvious that no deal can take place without some level of trust between the two parties.

I was reminded of this a few weeks ago when I had the opportunity to participate in an event, From DoG Street to Wall Street, at the College of William & Mary. The event connects current students interested in finance and investment banking with alumni, and I was happy return to my alma mater to answer questions and discuss my experience.

David Braun Dog St to Wall St

Participating in the investment banking roundtable discussion at From DoG Stree to Wall Street.

During the event I shared with students was the importance of trust and relationships in mergers and acquisitions. When I speak about relationships I don’t mean relying on your friends and network to make deals. I simply mean establishing a connection with another person. Especially in the world of not-for-sale acquisitions, paying attention to the human aspect of M&A is critical. Our philosophy is built on relationships and we work hand-in-hand with our clients from initial strategy development through deal execution in order to ensure they are in the best position for long-term, strategic growth. Some of our clients have stayed with us since we were first founded in 1995.

We not only take this approach with our clients, but also with the owners of acquisition prospects. In the world of privately held not-for-sale acquisitions trust is critical. Unlike in for-sale auctions, most owners of not-for-sale companies are not looking to sell their business to anyone, let alone a stranger, and many are initially distrustful of any potential buyers. Focusing on the mechanics of the transaction and financials at the onset is a sure way to kill any potential deal. The path to a successful acquisition begins with winning the owner’s trust, sharing your strategic vision, and developing a relationship that leads to mutually beneficial acquisition.

Photos courtesy of the College of William & Mary

Recent analysis shows that deal activity reached $435 billion in the first quarter of 2016 in North America and Europe. This is the second highest total on record and 84% of the deals were executed by strategic buyers.

Companies with lots of cash on their balance sheets and are now willing to deploy some of it to pursue larger deals that move the needle on revenue. Traditionally, companies can use their money to invest in organic growth, dividends for shareholders, or in acquisitions. In today’s environment, M&A makes the most sense for firms who have the cash and need to quickly spur growth.

In addition, strategics are not constrained by the same investment criteria as financial buyers like private equity firms. They can afford to pay more up front since they plan to hold onto the newly acquired company for long-term growth. On the other hand, private equity buyers are typically looking for return on their investment in three to five years.

Over the past week we’ve seen a number of interesting acquisitions by strategic acquirers, including Berkshire Hathaway’s $1 billion investment in Apple. And Pfizer’s purchase of Anacor Pharmaceuticals for $5.2 billion after its $152 billion merger with Allergan fell apart last month.

 

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Last week, thousands of investors gathered at Berkshire Hathaway’s annual shareholder meeting in Omaha. Warren Buffett, perhaps one of the greatest strategic acquirers, shared his insights for successful acquisitions. There are two pearls of Buffett wisdom, reported direct from the meeting by Dealbook that I’d like to highlight in this post.

Looking at the Big Picture

Buffett insists that the most important thing isn’t negotiating every fine point of a deal, but being right on the broader prospects of the potential takeover target.

I can confirm this from my own experience as an M&A advisor. Far too often I see company leaders getting caught up in the minutiae of a deal. While details do matter, the success of your acquisition doesn’t lie in the technicalities. You can get every detail exactly right, but if you acquire the wrong company, your acquisition is doomed to failure.

Think about buying a car that’s the exact shade of blue you want, but the transmission has been trashed! Or imagine purchasing your “dream home” that’s located in the wrong state. No matter what color the car, or how beautiful the house, neither is a good purchase when you take in the whole picture. If you’re getting bogged down in the weeds, take a step back and look at your strategic objectives.

Evaluating Future Demand

According to Buffett, “The mistakes [in mergers and acquisitions] are always about making an improper assessment of the economic future.”

When talking about is erroneous analysis of future demand for the product line of the business you’re about to acquire.

Understanding future demand is critical, because without demand for its products and services, any business risks becoming obsolete. So when you think about acquiring a company, consider what the market will look like in 5 or 10 years. Who will the customers be? What will be the demand for these kinds of products or services? Is this sector shrinking or growing? Without taking the market dynamics into consideration, you risk acquiring a dud.

These two points from Buffett may seem simple, but it can be easy to get caught up in the excitement of a deal or to over-focus on the details. Remember to take a step back and assess the entire situation, taking into account your own strategic goals and future demand. Evaluating an opportunity with this broader perspective will help increase your chances of a successful deal.

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In 2015, record valuations drove a boom in mergers and acquisitions activity, leaving many to wonder when the deal bubble would burst.

In 2015, US buyout firms paid an average of 10.3 times EBITDA compared with the previous record of an average 9.7 times multiple in 2007. Despite hitting a peak, valuations are still expected to remain high for some time.

So what is happening in the market today? Why are valuations so high, and how does this affect you?

High Valuations

One factor driving valuations higher and higher are sellers’ unrealistic expectations about valuation multiples.

According to consultant Joseph Feldman, many sellers, especially those who have never conducted a transaction before, tend to look at news articles with high-valued deals as a guide. Unfortunately, they don’t realize that those headliners are not representative of the market as a whole.

Private Equity vs. Strategic Buyers

There is lively competition between private equity and strategic buyers, but with such high valuation multiples, M&A today is still a strategic acquirers’ market, and financing remains relatively inexpensive.

Strategic acquirers have an advantage because they may be more willing to pay for higher valuations, on account of their more long-term focus. Private Equity firms tend to have have specific, short-term targets for return on investment, so they may be less willing to pay a premium.

Says Andrew Hulsh, Partner at Pepper Hamilton:  “These strategic corporate buyers, unlike private equity sponsors, may not need to be quite as concerned about the short-term impact of paying a higher price for these companies and assets, and can sometimes offset the premiums paid for these companies in part through business synergies and related cost savings.”

What Should You Do?

As a buyer focused on long-term growth, you have an advantage in today’s market. You may be willing to pay a bit more for a deal that makes strategic sense and will help you realize your goals. Price is always an important concern, of course. But it shouldn’t be the overriding factor. Long-term, it’s far cheaper to pay a bit more for the right company than to underpay for the wrong company. Acquiring the wrong company can prove a very costly mistake that is not easily fixed.

I’m not saying you should pay a multiple that doesn’t make sense. As always, you should remain strategic when pursuing M&A. Does the company fit in with your strategic rationale for acquisition? Also keep in mind there may be other non-financial aspects of the deal that this the right fit for you, and make you the preferred buyer for the target. Especially in the world of not-for-sale, privately held businesses, money isn’t everything.

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As we near the end of the fourth quarter, everyone is wondering what will happen in 2016. Will the frenzied M&A activity of 2015 continue into the new year?

There seem to be mixed reviews on what activity will look like next year. The Intralinks deal flow predictor indicates a 7% increase in global M&A in Q1 2016, but Mergers & Acquisitions Magazine has been citing a downward trend in the middle market for the past few months.

On the other hand, on a recent Deal Webcast “2016 Middle Market Outlook,” dealmakers were a bit more hopeful, expecting to see activity continue due to the high levels of dry powder and capital on the sidelines, while they did admit there may be a slight downturn.

The lending environment will be similar in 2016 to what it was in 2015 and in the middle market private equity will continue to be highly competitive, according to Michael Fanelli of RSM.

Healthcare and Technology Will Dominate

The Affordable Care Act brought about widespread changes to the healthcare industry, spurring a wave of mega-mergers by massive pharmaceutical companies. Despite this wave of mega-deals, for the most part much of the uncertainty surrounding ACA seems to have worked its way out of the middle-market companies. Tim Alexander of Harris Williams says that by and large, healthcare has become less of a due diligence item for dealmakers, especially those in the upper middle market.

On the other hand, in the lower middle market, the ACA may still raise some red flags, especially for businesses with part-time employees or ones that don’t have healthcare plans at all. While some sellers may have thought about the impacts of ACA, many are waiting to begin talks with a buyer before engaging professionals to deal with these issues, according to Fanelli.

The focus on healthcare is not only due to changes brought about from the Affordable Care Act, but is also indicative of a larger health and wellness trend we’re seeing in the U.S. Expect shakeups in the consumer and food and beverage spaces as people focus on healthier, organic specialty products.

As for technology, there’s plenty of disruption that will continue over the next one to two years, with a constant flow of innovative startups. This continuing trend will have its own impact on the middle market.

The U.S. Middle Market Remains Strong

For the most part, all three dealmakers agreed that middle market M&A is much stronger in the U.S. than it is cross-border or internationally. Most investors see the U.S. as the locale where they can expect their highest returns. This regional focus is not unique to the middle market: In the first 9 months of 2015, the U.S. accounted for 47% of global M&A transactions ($1.5 trillion).

Engaging with Sellers Remains Critical

When it comes to deal-making, building a connection with the owner and sharing your strategic vision remain the critical starting points. There are numerous reasons why an owner may decide to go with a financial buyer over a strategic buyer, even though technically strategic buyers should have an advantage from a cash perspective. In our experience, the same has been true (less money for strategic acquisition vs. financial). What it comes down to is really understanding the owner’s priorities and what he or she wants out of an acquisition. Hint: It’s not always more money.

As Marc Utay of Clarion Capital Partners said, echoing one of our key principles: “Price is important, but not the most important thing. It [the company] is like a child to them.”

 

By now, many of you will have heard of Berkshire Hathaway’s $37.2 billion acquisition of Precision Castparts Corp. (PCC), an aerospace parts manufacturer. The acquisition is Berkshire Hathaway’s largest to-date which goes to show with each strategic acquisition, Berkshire Hathaway must make bigger and bigger deals to “move the needle.”

Strategic and to the Point

The straightforward nature of the deal’s press release is particularly refreshing and reflective of Warren Buffett’s overall attitude toward strategic acquisitions.

“I’ve admired PCC’s operations for a long time. For good reasons, it is the suppler of choice for the world’s aerospace industry, one of the largest sources of American exports,” said Warren Buffet.

Mark Donegan, PCC’s chairman and chief executive officer stated: “We see a unique alignment between Warren’s management and investment philosophy and how we manage PCC for the long-term.”

You can read the full press release here.

You’ll notice there are no flowery words or long-winded paragraphs in the press release, unlike the now infamous AOL-Time Warner deal. As I’ve stated before on this blog and in my book, at Capstone, we are big proponents of having only ONE reason for acquisition. Having a simple, clear, strategic path forward leads to success. On the other hand, pursuing many reasons makes the deal unnecessarily complicated and unfocused.

Finding Growth through M&A

Warren Buffett’s latest acquisition reflects the overall trend in the market – M&A is the pathway to growth. Dealogic data reports $2.63 trillion in deals as of August 3, perhaps the most robust year yet. The Wall Street Journal notes, robust M&A “…has been driven largely by companies buying others to drive growth at a time when earnings increases aren’t easy to achieve.”

Organic growth options are anemic or stagnant at best, forcing companies to seriously consider M&A to drive growth. In today’s market, businesses cannot be content to sit on the side lines and go about business as usual. They should take a careful look at all of their growth options – including acquisitions – and determine the best path forward based on a strategic, proactive approach. Those who fail to move now and consider their strategy for growth will be unfortunately be left behind.

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Credit unions have in the past year or so embraced strategic mergers and acquisitions with fervor. This was especially evident at the CUES Execu/Summit I spoke at last week.

While strategic M&A in the credit union industry is not new, I’m excited about the enthusiasm that now surrounds the topic.

Capstone has been active in the industry facilitating deals and developing strategic growth plans for over 10 years.

When we began working with credit unions in 2003, we found strategic M&A was on fewer people’s radars and that fewer credit union leaders understood the advantages of or even considered strategic mergers and acquisitions. Now, pressed by regulatory changes and marketplace dynamics, the tide is changing. I for one am very excited to see what new opportunities will become available as a result of embracing strategic deals.

Capstone CEO and author David Braun will present “Grow or Die: Strategic Mergers and Acquisitions” at the CUES Execu/Summit on March 3, 2015 at Snowmass, Colorado.

CUES is a leading organization dedicated to educating credit union professionals, directors and suppliers. About 80-90 executives and board members from the credit union industry will attend the Execu/Summit to hear from top experts and learn about critical issues facing credit union leaders today.

Mergers and acquisitions is especially a hot topic and many of these leaders have specifically requested more information about strategic M&A.

We are excited to be participating in this conference.

Capstone has over 10 years of experience working with credit union and credit union service organization clients. David will draw upon this expertise to offer industry-specific applications of M&A.

“I’m excited to challenge credit union leaders to think about a new way to grow – by using strategic mergers and acquisitions,” he said. “At Capstone, our mission is to help companies grow and I’m happy to equip leaders with practical skills that they can take back to their organizations and start implementing in their strategic growth plans.”

If you’re strategic acquirer, 2015 will be a good year for you.

In 2014 we started to see companies, especially strategic acquirers be more aggressive about M&A. This likely will continue and even accelerate in 2015, especially since many still have a record amount of cash on their balance sheets.

US Mergers and Acquisitions 2014

While we’ve had a pretty significant growth in deal value over the past year (50%), the number of deals has only increased 8%. Average deal size has increase significantly by 39% when compared to 2013 values. This is sort of a caution flag out there for folks to say, “Let’s be careful about overpaying.”

Part of the challenge for strategic acquirers in 2015 will be weighing the cost of overpaying against the consequence of not being involved in some of these deals. While there is no reason to be alarmed, strategic buyers should pay attention to multiples in the coming year.

Despite this, there is still opportunity for strategic buyers. In the last quarter of 2014, we continued to see a decline in the capital raised and the number of deals closed by private equity firms.

US PE Deal Flow 2014

This is all good news if you’re a strategic acquirer because it means less competition. In addition, you should be seeing more strategic value in the form of synergies primarily around cost savings.